US corporate treasurers and financial institutions are being urged by the Federal Reserve and the Securities and Exchange Commission (SEC) to lessen the risk of market disruption by accelerating the phase-out of the London Interbank Offered Rate (LIBOR) before its official end at the end of December and switching to its successor, the Secured Overnight Financing Rate aka SOFR.
SOFR is the reference rate favoured by the Alternative Reference Rates Committee (ARRC), a panel of banks, insurers corporates and asset managers backed by the Fed that includes Bank of America, Citigroup, Deutsche Bank, Fannie Mae, Ford, MetLife, Goldman Sachs, BlackRock, the American Bankers Association and the National Association of Corporate Treasurers.
The ARC “recommends that all market participants act now to slow their use of US dollar (USD) LIBOR and leverage the next six weeks as a key window to reduce such activity to promote a smooth end to new LIBOR contracts by the end of the year,” the panel said on 14 October
“Taking a proactive approach over a period of time – rather than at a defined end point under which prevailing liquidity conditions could have an outsized impact – is in the interest of market participants seeking to end new use of USD LIBOR and to support smooth market functioning,”
No deadline extension
Regulators have stipulated that LIBOR – which has served as the global benchmark for more than US$200 trillion in business loans, mortgages, derivatives and other financial contracts – may no longer be used as the reference rate in new financial contracts after 31 December.
SEC Chair Gary Gensler recently warned that some market instability from the end of LIBOR is possible later this year as regulators will not extend the deadline into 2022. “Most of the market adjusts pretty smoothly,” he commented, but in “some it gets choppy because you can’t anticipate everything and some people, frankly, wait for the last time."
Fed Vice Chair Randal Quarles has also urged lenders and corporate borrowers to speed up the pace of their switch to SOFR, noting that they used LIBOR alternatives for less than 1% of corporate loans and 8% of derivatives in Q2 of 2021. “Market participants should act now to accelerate their transition away from LIBOR,” he said. “The reign of LIBOR will end imminently, and it will not come back.”
The final fixings for most LIBOR rates – including one-week and two-month U.S. dollar LIBOR – will be made on 31 December2021, but other US dollar tenors may continue until 30 June 2023.
SOFR gaining traction
The market for derivatives linked to SOFR – which is based on overnight repurchase agreements secured by US Treasury and, unlike LIBOR, does not reflect credit risk – has grown since July, when the ARRC endorsed the benchmark for use in a series of term rates.
“Proactive reductions in new USD LIBOR contracts should apply across markets and across the full range of derivatives and cash products, including but not limited to syndicated and bilateral loans,” the ARRC said. “All market participants should be ready for the year-end US supervisory guidance deadline.
“The ARRC applauds the leadership demonstrated by firms who have such plans already underway and encourages those without such plans to immediately commence efforts to significantly slow their new USD LIBOR activity.”
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